Comgades! The ggeat October Shareholder Gevolution that has been long advocated by the Gagdneg Bgothegs..is over!
The Fool's front page is alive with revolutionary proposals aimed at complete reorganization of the corrupt corporate structure. Now, I have no doubt that all 6 proposals put forth by Dayana Yochim are valid and we should all support these proposals. But in the end, a palliative solution almost never succeeds and in fact often does damage by helping sustain a structure that should really be brought down. And in discussing the effectiveness of various medicines intended to treat the symptoms, I feel that we forgot to address the main cause of the desease.
After all, the stock market is innately a very competetive system. There are many thousands of companies out there. The fortune 500 alone has 500 major corporations. It's not the case of a monopolized market controlled by a dozen major players. If honest corporate practices were really valued by shareholders, then the competitive stock market would soon deliver what they want. The way this process would work is pretty straightforward: a clever businessman would start an honest company, get rewarded by a higher PE ratio than his crooked rivals, and then would use that higher ratio to buy them out. The next step is self-obvious: after buying out a rival, he would remove the old management and introduce the same high corporate standards that he follows in his own company. Which, in turn, would increase his market cap, providing him with still more money with which to buy corrupt companies. Eventually the market would sort things out and transparent management would become the norm.
So why do we have instead this stodgy, corrupt structure that we feel can only be reformed from the outside?
The simple answer is that shareholders don't seem to care much about the quality of what they are buying. Though they may have a slight preference for well-run companies like BRKa, they don't see honest management as a critical factor. And so CEOs are able to get away with questionable practices because shareholders never get to question them.
And why don't shareholders ever question those practices? Well, why should they? After all, the market is always growing, returning 7% after inflation, right? As long the market shows this kind of growth, shareholders are sure to support the crooked managers who deliver that growth, without asking too many questions. In fact, a growing market will very likely make you look stupid for asking these questions once you voice your concernes only to see that stock lemon go up to the stratosphere.
And what makes the masses buy this myth of ever-rising stock market? For one, the dot-com bubble did its job. It lasted for about 8 years, so it was inevitable that it would take at least that much to cleanse the greater-fool mentality from the system. Secondly, the easy money from Greenspan assured, or at least seemed to assure, that even a lousy investment would not perform too badly. Third, the unprecedented support of the market after the dot-com debacle kept the floor in place and produced enough secular bear market rallies to impress the public, at least until last year. Then again, the Paulson-Bernanke-Geitner bailout made fools of everyone who kept saying that GS at $60 was not a good investment becuase it was being run by a most venal group of executives who would eat minority shareholders for breakfast, lunch, and dinner. And they were right of course. But when the ex-CEO of GS Hank Paulson wrote a hundred billion dollar check to rescue the failed AIG investment of the current CEO of GS Lloyd Blankfein, it no longer mattered. Naturally, GS managers wrote themselves another bonus and the stock tripled. Most other financials fared in a similar manner, maybe not as spectacularly well as GS because they didn't have their alumni working as the Secteraty of the Treasury, but their story was essentially the same. And finally, there is always the financial industry spinning its fairy tales about those perpetual 7% returns. If your average stock is going to earn you 7%, who cares that the CEO has pocketed 1% in options, staffed the board with his lackeys and took on a 30-1 leverage? Especially since banks are too big to fail anyway?
Before 1980s people at least paid attention to what they were buying, that's why valuations were reasonable and managers were not receiving obscene bonuses like today. The corporations could still flush out the excesses on their own without need for external regulation given the right economic environment. If the public were given a chance to realize that not every crook can succeed as a CEO, a more responsible behavior might ensue. A Fed Funds rate of 6%, a 3% cap on money supply growth, and an end to al bailouts would be of great help. When a positive return is no longer guaranteed, you'd better make sure that your CEO is adequate for the job.